Solvency and Financial Condition Report The United Kingdom Mutual Steam Ship Assurance Association (Europe) Limited Year ended 20 February 2017
Contents A. Summary... 3 Directors Statement... 3 Auditors report... 4 A.1. Business... 9 A.2. Underwriting performance... 10 A.3. Investment performance... 11 A.4. Performance from other activities... 12 A.5. Any other information... 12 B. System of Governance... 13 B.1. General Information on the System of Governance... 13 B.1.1. Overview... 13 B.1.1.1. Committee Structure... 13 B.1.1.2. Outsourcing... 14 B.1.1.3. Key Functions... 14 B.1.2. Remuneration... 15 B.1.3. Related party transactions... 15 B.2. Fit and Proper Requirements... 16 B.3. Risk Management System... 16 B.4. Internal Control System... 21 B.5. Internal Audit Function... 22 B.6. Actuarial Function... 23 B.7. Outsourcing... 23 B.8. Any Other Information... 24 C. Risk Profile... 25 C.1. Underwriting Risk... 25 C.2. Market Risk... 26 C.3. Credit Risk... 28 C.4. Liquidity Risk... 29 C.5. Operational Risk... 30 C.6. Other Material Risks... 30 C.7. Any Other Information... 30 D. Valuation for Solvency Purposes... 31 D.1. Assets... 31 D.2.Technical Provisions... 33 D.3. Other liabilities... 36 D.4. Alternative methods of valuation... 37 1 Page
D.5. Any other information... 37 E. Capital Management... 38 E.1 Own funds... 38 E.2 Solvency Capital Requirement and Minimum Capital Requirement... 39 E.3 Use of the duration-based equity risk sub-module in the calculation of the Solvency Capital Requirement... 40 E.4 Differences between the standard formula and any internal model used... 40 E.5 Non-compliance with the Minimum Capital Requirement and non-compliance with the Solvency Capital Requirement... 41 E.6 Any other information... 41 2 Page
A. Summary This Solvency and Financial Condition Report ( SFCR ) covers the Business and Performance of the Association, its System of Governance, Risk Profile, Valuation for Solvency Purposes and Capital Management. The ultimate Administrative Body that has the responsibility for all of these matters is the Association s Board of Directors, with the help of various governance and control functions that it has put in place to monitor and manage the business. The Association s internal model has been approved for the calculation of the insurance risk elements of the Solvency Capital Requirement ( SCR ) with the remainder calculated using the standard formula. For SCR purposes the Association s total eligible own funds stood at $223.4 million. This includes ancillary own funds, as approved by the Association s regulator. Eligible own funds cover the SCR (of $118.4 million) by 189% and the Minimum Capital Requirement ( MCR ) (of $29.6 million) by 622%. Directors Statement We acknowledge our responsibility for preparing the SFCR in all material respects in accordance with the PRA Rules and the Solvency 2 Regulations. We are satisfied that: a) throughout the financial year in question, the Association has complied in all material respects with the requirements of the PRA Rules and the Solvency 2 Regulations as applicable to the insurer; and b) it is reasonable to believe that the Association has continued so to comply subsequently and will continue so to comply in future. Director For and on behalf of the United Kingdom Mutual Steam Ship Assurance Association (Europe) Limited 23 June 2017 3 Page
Auditors report Report of the external independent auditor to the Directors of The United Kingdom Mutual Steam Ship Assurance Association (Europe) Limited ( the Company ) pursuant to Rule 4.1 (2) of the External Audit Chapter of the PRA Rulebook applicable to Solvency II firms Report on the Audit of the relevant elements of the Solvency and Financial Condition Report Opinion Except as stated below, we have audited the following documents prepared by The United Kingdom Mutual Steam Ship Assurance Association (Europe) Limited as at 20 February 2017. The Valuation for solvency purposes and Capital Management sections of the Solvency and Financial Condition Report of The United Kingdom Mutual Steam Ship Assurance Association (Europe) Limited as at 20 February 2017, ( the Narrative Disclosures subject to audit ); and Company templates S02.01.02, S17.01.02, S23.01.01, S28.01.01 ( the Templates subject to audit ). The Narrative Disclosures subject to audit and the Templates subject to audit are collectively referred to as the relevant elements of the Solvency and Financial Condition Report. We are not required to audit, nor have we audited, and as a consequence do not express an opinion on the Other Information which comprises: Information contained within the relevant elements of the Solvency and Financial Condition Report set out about above which are, or derive from the Solvency Capital Requirement, as identified in the Appendix to this report; The Business and performance, System of governance and Risk profile elements of the Solvency and Financial Condition Report; Company templates S05.01.02, S05.02.01, S.19.01.21, S.25.02.21; The written acknowledgement by management of their responsibilities, including for the preparation of the solvency and financial condition report ( the Responsibility Statement ). 4 Page
To the extent the information subject to audit in the relevant elements of the Solvency and Financial Condition Report includes amounts that are totals, sub-totals or calculations derived from the Other Information, we have relied without verification on the Other Information. In our opinion, the information subject to audit in the relevant elements of the Solvency and Financial Condition Report of The United Kingdom Mutual Steam Ship Assurance Association (Europe) Limited as at 20 February 2017 is prepared, in all material respects, in accordance with the financial reporting provisions of the PRA Rules and Solvency II regulations on which they are based, as modified by relevant supervisory modifications, and as supplemented by supervisory approvals and determinations. Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (ISAs (UK)) including ISA (UK) 800 and ISA (UK) 805, and applicable law. Our responsibilities under those standards are further described in the Auditor s Responsibilities for the Audit of the relevant elements of the Solvency and Financial Condition Report section of our report. We are independent of the United Kingdom Mutual Steam Ship Assurance Association (Europe) Limited in accordance with the ethical requirements that are relevant to our audit of the Solvency and Financial Condition Report in the UK, including the FRC s Ethical Standard as applied to public interest entities, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Conclusions relating to going concern We have nothing to report in respect of the following matters in relation to which the ISAs (UK) require us to report to you where: the directors use of the going concern basis of accounting in the preparation of the SFCR is not appropriate; or the directors have not disclosed in the SFCR any identified material uncertainties that may cast significant doubt about the company s ability to continue to adopt the going concern basis of accounting for a period of at least twelve months from the date when the SFCR is authorised for issue. Emphasis of Matter Basis of Accounting We draw attention to the Valuation for solvency purposes and Capital Management and other relevant disclosures sections of the Solvency and Financial Condition Report, which describe the basis of accounting. The Solvency and Financial Condition Report is prepared in compliance with the financial reporting provisions of the PRA Rules and Solvency II regulations and Solvency II regulations, and therefore in accordance with a special purpose financial reporting framework. The Solvency and Financial Condition Report is required to be published, and intended users include but are not
limited to the Prudential Regulation Authority. As a result, the Solvency and Financial Condition Report may not be suitable for another purpose. Our opinion is not modified in respect of this matter. Other Information The Directors are responsible for the Other Information. Our opinion on the relevant elements of the Solvency and Financial Condition Report does not cover the Other Information and, we do not express an audit opinion or any form of assurance conclusion thereon. In connection with our audit of the Solvency and Financial Condition Report, our responsibility is to read the Other Information and, in doing so, consider whether the Other Information is materially inconsistent with the relevant elements of the Solvency and Financial Condition Report, or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If we identify such material inconsistencies or apparent material misstatements, we are required to determine whether there is a material misstatement in the relevant elements of the Solvency and Financial Condition Report or a material misstatement of the Other Information. If, based on the work we have performed, we conclude that there is a material misstatement of this Other Information, we are required to report that fact. We have nothing to report in this regard. Responsibilities of Directors for the Solvency and Financial Condition Report The Directors are responsible for the preparation of the Solvency and Financial Condition Report in accordance with the financial reporting provisions of the PRA Rules and Solvency II regulations. The Directors are also responsible for such internal control as they determine is necessary to enable the preparation of a Solvency and Financial Condition Report that is free from material misstatement, whether due to fraud or error. Auditor s Responsibilities for the Audit of the relevant elements of the Solvency and Financial Condition Report It is our responsibility to form an independent opinion as to whether the relevant elements of the Solvency and Financial Condition Report are prepared, in all material respects, with financial reporting provisions of the PRA Rules and Solvency II regulations on which they are based Our objectives are to obtain reasonable assurance about whether the relevant elements of the Solvency and Financial Condition Report are free from material misstatement, whether due to fraud or error, and to issue an auditor s report that includes our opinion. Reasonable assurance is a high level of assurance, but it is not a guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the decision making or the judgement of the users taken on the basis of the Solvency and Financial Condition Report. 6 Page
A further description of our responsibilities for the audit of the financial statements is located on the Financial Reporting Council s website at: https://www.frc.org.uk/our-work/audit/audit-and-assurance/standards-andguidance/standards-andguidance-for-auditors/auditors-responsibilities-foraudit/description-of-auditors-responsibilities-for-audit.aspx Other Matter The Company has authority to calculate its Solvency Capital Requirement using a partial internal model ( the Model ) approved by the Prudential Regulation Authority in accordance with the Solvency II Regulations. In forming our opinion (and in accordance with PRA Rules), we are not required to audit the inputs to, design of, operating effectiveness of and outputs from the Model, or whether the Model is being applied in accordance with the Company s application or approval order. Report on Other Legal and Regulatory Requirements. In accordance with Rule 4.1 (3) of the External Audit Chapter of the PRA Rulebook for Solvency II firms we are also required to consider whether the Other Information is materially inconsistent with our knowledge obtained in the audit of The United Kingdom Mutual Steam Ship Assurance Association (Europe) Limited s statutory financial statements. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. Michael Butler (Senior Statutory Auditor) For and on behalf of Moore Stephens LLP, Statutory Auditor 150 Aldersgate Street, London. EC1A 4AB 7 Page
Appendix relevant elements of the Solvency and Financial Condition Report that are not subject to audit Solo partial/internal model The relevant elements of the Solvency and Financial Condition Report that are not subject to audit comprise: The following elements of template S.02.01.01: Row R0550: Technical provisions non-life (excluding health) risk margin Row R0590: Technical provisions health (similar to non-life) risk margin Row R0640: Technical provisions health (similar to life) risk margin Row R0680: Technical provisions life (excluding health and index-linked and unit-linked) risk margin Row R0720: Technical provisions Index-linked and unit-linked risk margin The following elements of template S.17.01.02 Row R0280: Technical provisions calculated as a sum of BE and RM Risk margin Rows R0290 to R0310 Amount of transitional measure on technical provisions The following elements of template S.23.01.01 Row R0580: SCR Row R0740: Adjustment for restricted own fund items in respect of matching adjustment portfolios and ring fenced funds Elements of the Narrative Disclosures subject to audit identified as unaudited. 8 Page
A.1. Business Corporate information The United Kingdom Mutual Steam Ship Assurance Association (Europe) Limited ( UKE or The Association ) is incorporated in England and Wales as a company limited by guarantee without share capital. UKE s parent company is The United Kingdom Mutual Steam Ship Assurance Association (Bermuda) Limited, ( UKB ) which is registered in Bermuda as a company limited by guarantee without share capital. The Group's parent undertaking, UKB, is the sole member of the UKE and therefore holds all voting rights. Group structure Collectively these entities form the Group. The group structure, including all active companies, is as follows: Table 1: The Group Structure UK P&I Club Bermuda UK Europe (100%) UKL (100%) Hydra Insurance company Ltd (100% of cell) The principal activity of the Association is the insurance and reinsurance of marine protection and indemnity risks on behalf of the Members. The Group operates as a single business. All policies of insurance issued by the Group are written by UKE and all policyholders of UKE are members of UKB. The policyholders therefore hold all voting rights of UKB and the Group. UKE reinsures 90% of all premium income and claims incurred to UKB (net of external reinsurance). Hydra Insurance Company operates through several segregated cells. One of these cells provides reinsurance to the Association for claims in excess of $30 million arising from mutual owned business. 9 Page
The United Kingdom Mutual Steam Ship Assurance Association Limited ( UKL ) ceased writing new business in 1971. All liabilities arising from business written by UKL are fully reinsured by UKE. The authority responsible for the financial supervision and review of the SFCR of the Group is the Prudential Regulatory Authority which is located at 20 Moorgate, London EC2R 6DA The Association is also regulated by the Financial Conduct Authority ( FCA ): 25 the North Colonnade, London, E14 5HS, United Kingdom. The external auditor of the Association is Moore Stephens LLP located at 150 Aldersgate Street, London, EC1A 4AB, United Kingdom. A.2. Underwriting performance Underwriting performance measures The Association s target is to call sufficient premium to cover its claims and expenses as measured by the combined ratio. Since claims vary from one year to another, the Association considers performance against this target over the medium term by monitoring the average financial year combined ratio. To achieve the combined ratio target, the Association focusses on disciplined underwriting based on appropriate risk selection as informed by a thorough understanding of risk. The Association employs techniques such as programmes for loss prevention and efficient reinsurance purchase to manage the risk accepted. S.05.02.01 includes a geographical split of the Association s business based on the flag of the vessel insured. Recent Underwriting performance The Association operates a single line of business being Protection and Indemnity insurance for the shipping community. The Association therefore reports all business within this single line and does not report additional analysis by business segment. The Association s target is to call sufficient premium to meet claims and expenses at group level over the medium term for the Group as a whole. The average combined ratio over the last seven years is 100% (excluding supplementary calls and mutual premium discounts) and therefore the Group has met its underwriting target over the previous seven years. By achieving this target the Group has been able to discount mutual premium rates three times in the previous five years. The total discount amounts to $19.6 million. 10 Page
Table 2: Recent underwriting performance for UKE Amounts in $000 2017 2016 Income Gross earned premium 386,166 393,613 Mutual premium discount (9,996) (8,253) 376,170 385,360 Premium ceded to reinsurers (303,240) (310,839) Net earned premium 72,930 74,521 Net investment return 1,260 4,603 Total net income 74,190 79,124 Expenses Claims and claims adjustment expenses net of reinsurance (24,269) (20,402) Expenses for the acquisition of insurance contracts (19,988) (20,303) Net operating expenses (21,119) (22,165) Foreign exchange (losses)/gains (6,809) (2,788) Total expenses (72,185) (65,658) Results from operating activities 2,005 13,466 Total net premium income fell by $1.6 million to just below $73 million. The Association benefits from significant reinsurance cover. A greater number of large claims were incurred by the Association during the 2016 policy year than in the 2015 policy year although the total cost of the year was higher than last year but in line with expectations. The 2015 policy year was particularly favourable. Total expenses were broadly in line with the previous year. The overall surplus was transferred to the reserves of the Association. A.3. Investment performance In accordance with the investment policy, the investment mandate is updated on a regular basis. The asset allocation established within the mandate is principally determined to ensure that the Association s future cash flows arising from liabilities (principally claims reserves) are matched by available assets of the correct currency and duration. Effective risk management is therefore the principal driver of investment allocation. Having established a matched portfolio, the Association accepts limited investment risk to achieve the best return available from the surplus assets. Some factors that may influence future investment return are: 11 Page
Market performance as affected by macro-economic, political or other factors Capital allocation and risk profile determining the risk accepted into the portfolio Portfolio management including asset allocation (both strategic and tactical) Asset allocation The following table provides the breakdown of the Association s investment portfolio. Asset allocation within UKE The investment portfolio is entirely invested in government and corporate bonds. The total portfolio returned $1.3 million (excluding currency losses) over the 2016/17 financial year. Investment returns per the IFRS financial statements are further detailed in the table below: Amounts in $000 2017 2016 Investment income Dividend income 851 - Interest on fixed income securities 4,833 5,094 Bank deposit interest 26 6 Other investment charges (715) (1,012) Total investment income 4,995 4,088 Net realised gains on financial assets at fair value through profit and loss - Debt securities (1,643) (442) - Equity securities (3) - Total net realised gains on financial assets (1,646) (442) Net fair value gains on financial assets through profit and loss - Debt securities (2,176) 957 - Equity securities 87 - Total (2,089) 957 Total investment return 1,260 4,603 A.4. Performance from other activities As noted in A.2. all of the Association s activities relate to its core business. A.5. Any other information The Association does not consider that the disclosure of any other information is necessary. 12 Page
B. System of Governance B.1. General Information on the System of Governance B.1.1. Overview The Board directs, and has responsibility for, all activities of the Association. The Directors are drawn principally from the ship-owner members, supplemented by other Directors with specialist knowledge or executive responsibilities. The Board has outsourced the day to day management of the Association to a third party, Thomas Miller P&I (Europe) Limited or the Managers The Board of UKE consists of 8 ship-owner directors, two specialist directors and two executive directors. The two executive directors are the CEO and the CFO of the Managers. The Board consider that the System of Governance is appropriate for the nature, scale and complexity of the inherent risks facing the Association. The Board is supported by several committees. B.1.1.1. Committee Structure The Members Committee ( MEMCO ) MEMCO provides a forum for Members to play an enhanced role in the governance of the Club in relation to mutual member issues and provides members perspective on matters which are relevant to the business of the Club. Audit & Risk Committee ( ARCO ). ARCO is responsible for monitoring the risk management system and internal control framework against the Board s risk appetite. ARCO directs the internal audit function and oversees the external audit function to gain assurance over significant risks. ARCO considers the results of the internal model validation exercise and oversees regulatory and statutory reporting. Strategy Committee ( STRATCO ). STRATCO assists the Board in formulating strategy and providing reports and recommendations on strategic issues and any other issues affecting the Association. The Committee meets on an ad-hoc basis and specifically 13 Page
conducts an annual review of a strategic risk assessment and a review of strategy. Ship & Membership Quality Committee ( QUALCO ). QUALCO provides the Board with advice regarding the criteria used to establish the suitability of Members. QUALCO also considers whether individual ships or fleets meet the underwriting criteria. Nominations Committee ( NOMCO ). NOMCO ensure that the Board continues to be composed of suitably qualified and skilled individuals. It also makes recommendations to ensure that the Committees of the Board are composed of individuals appropriate to the respective roles. Investment Committee (IVCO). IVCO makes recommendations to the Board in respect of the Investment Mandate and reviews in detail the performance of the investment portfolio. Material changes Over the previous 12 months the Association formed the Members Committee (as described above). B.1.1.2. Outsourcing The Association outsources all functions, including controlled functions, to the Managers. The Managers aim to provide a governance framework to facilitate the Association s strategic plan whilst managing risks. The Managers operate through several committees, all of which report to the Thomas Miller P&I (Europe) Board ( TM P&I (E) Board ). These committees include risk, finance, operations, reinsurance, data governance and credit worthiness. B.1.1.3. Key Functions The Managers The Association has no direct employees, except within the Japan Branch, and as such the Board relies on the Managers for the day-to-day management duties of the Association. The Investment Managers Investment of the Association's funds is conducted by the Investment Managers in accordance with the Board s Investment Policies and is subject to internal compliance procedures. 14 Page
Governance map The Association maintains a governance map that details Senior Insurance Manager Functions and Key Functions. According to the governance map, the following functions are maintained with a prescribed set of responsibilities. These are performed by: - Chairman (Director) - Group Entity Senior Manager (Director) - Chief Executive Officer (Director) - Chief Financial Officer (Director) - Chairman of Audit and Risk Committee (Director) - Chief Actuary (Manager) - Chief Risk Officer (Manager) - Chief Underwriting Officer (Manager) - Chief Claims Officer (Manager) - Head of Internal Audit (Manager) B.1.2. Remuneration The Association outsources all executive matters to the Managers in accordance with the Management Agreements. The Managers operate a formal group performance and merit-based remuneration policy aimed at paying competitive and appropriate remuneration consistent with the longterm interest of the business. The Association s Remuneration Policy sets out how the Managers are remunerated under a management fee agreement. This is agreed periodically by the Board. B.1.3. Related party transactions The Association has no share capital and is controlled by UKB. All policyholders of the Association are members of UKB and hence insurance transactions are between related parties, but these are the only transactions between the Association and the Members. All of the shipowner Directors are representatives of Member companies and have no financial interests in the Association, other than the insurance of their ships entered in the Association, which is arranged on an arm s length basis, and the Member interests of their companies. Directors are paid an annual fee and an attendance fee for each meeting. There are no variable components to the directors remuneration. 15 Page
B.2. Fit and Proper Requirements The Association has in place a Fit & Proper Policy that sets out its approach to the fitness and propriety of the persons responsible for running the Association, including executive senior management and key function holders. All persons within the scope of the Association's Fit and Proper policy must have the professional qualifications, knowledge and experience and demonstrate the sound judgement necessary to discharge their areas of responsibility competently. They must be of good repute and demonstrate in their personal behaviour and business conduct character, integrity and honesty. As part of the assessment consideration will be given to potential conflicts of interest and financial soundness. The Board members must collectively possess sufficient knowledge, competence and experience to direct and oversee the Association s affairs effectively. The Managers maintain role specifications for all executive roles that are within the scope of the Fit and Proper policy which detail the key competencies and duties for each position. Fit and proper assessments are carried out by the Compliance Officer both annually through declarations and formally every three years. No person is permitted to undertake their own assessment. The Association s Fit & Proper Policy applies to: All Directors of the Association and Committees; All employees of the Managers who are members of the Thomas Miller P&I (E) s senior management; and Persons within the Managers responsible for key functions. B.3. Risk Management System The Association s Risk Management System The Association uses a Risk Management Framework to design an effective risk management system with an integrated approach to risk management and the application of the three lines of defence: 1st line of defence: business units and all staff not included in the second and third lines of defence, process and risk owners 2nd line of defence: risk management and compliance functions 3rd line of defence: internal and external audit The risk management system incorporates the accurate and appropriate identification, recording, analysis, reporting and mitigation of risk. The Board has: 16 Page
a clearly defined and well-documented risk management strategy; adequate written policies; appropriate processes and procedures; appropriate reporting procedures; reports on the material risks faced by the Association and on the effectiveness of the risk management system; a suitable Own Risk and Solvency Assessment (ORSA); The risk management system not only covers the risks included in the calculation of the Solvency Capital Requirement but also other risks to which the Association is exposed and which are considered by the Association to be materially relevant to its business. The Partial Internal Model (PIM) The internal model is a key risk management tool within the Risk Management Framework. It has been developed by the Actuarial Function in conjunction with the Managers Risk Committee which fulfils the Risk Management Function of the Association. The internal model is used for the calculation of certain elements of the Solvency Capital Requirement. As the outputs of the PIM are being used to replace parts of the Solvency II standard formula calculation, they are subject to additional governance and validation requirements. The Managers Risk Committee is responsible for determining the scope of the internal model and the PIM. The internal model is used to analyse the impact of any risk management decisions and changes to the Association s risk profile falling within the scope of the model on the Association s regulatory and internal capital requirements. In particular, the Solvency Capital Requirement and the Own Solvency Needs Assessment will be calculated whenever the model is used to determine the capital implications of any changes to the Association s risk profile. The results of these analyses are reported in the ORSA. All uses of the model are recorded in an internal model uses log maintained by the Actuarial Function. The Actuarial Function also carried out an annual model performance review on the PIM, with the results reported to the Managers Risk Committee and subsequently presented to the Audit & Risk Committees of the Association. The review may result in decisions to change the scope of or otherwise improve the model. The use of the PIM is subject to the Internal Model Governance Framework which covers processes and controls applied. Changes to the PIM are subject to the Internal Model Change Policy and validation is carried out in accordance with the Internal Model Validation Policy. The risk management system also has a coherent focus on data and IT infrastructure governance and appropriate policies and standards to outline the framework within which responsibilities are exercised. It is supported by a robust internal control system and is designed to identify measure, manage, 17 Page
monitor and report significant risks to the achievement of the Association s business objectives. Risk Management Strategy The objectives of the Association s risk management strategy are to identify, measure, monitor, manage and report in a consistent, continuous and timely fashion, on the basis of the Association s risk appetite as set by the Board and documented in the Corporate Plan. The Risk Management Framework helps both support and relay the Association s business plan strategy throughout the organisation by ensuring that those factors that may advance or impede the achievement of strategic and operational objectives are managed by strong controls. The risks to which the Association is exposed are recorded in the Business Risk Log. Key Risks A list of key risks has been compiled by the Board and senior management of the Association based on their experience and expert judgement in running the business. This list provides a high-level overview of the principal risks faced by the business which, individually or in combination, may have a significant, substantial or severe impact on the Association. Implementation of the Risk Management Strategy: Risk Policies and Procedures The Association s strategy is specified in more detail through its policies and Corporate Plan which underpin its day-to-day business. It sets out the systematic application of management policies, procedures and practices that are used to identify, manage and communicate risk to facilitate Board decision-making and to provide an effective system of risk management. Policies have been developed for all material risks to which the Association is exposed, including policies relating to the internal model. They define the Association s approach to risk management overall and more specifically the risk for which the policy has been written. The policies establish the controls, procedures, limits and escalation to ensure that the risks are managed in line with risk appetite. Specific procedures, where appropriate, have been developed to provide full understanding of the means by which the first and second lines of defence will implement the strategy. The policies also include appropriate reporting procedures to ensure that information relating to the component elements of the risk management is routinely reported to the Audit & Risk Committee and to the Board. Risk Appetite The Association s Risk Appetite is articulated in the statement of risk appetite, which is a document owned by the Board and reviewed on a regular basis as new risks emerge, or at least annually 18 Page
The Board bears ultimate responsibility for the management of risk and for maintaining a sound system of internal control that supports the achievement of the business strategy, policies, aims and objectives of the Association. ARCO supports the Board by providing oversight of the Risk Management Function. Business Risk Log: Assessment, Measurement and Management Risks to the business that could inhibit the Association achieving its business plan objectives are described in the Business Risk Log, together with the consequences should the risk materialise. Emerging Risk Log Risk Owners identify potential emerging risks which are then discussed at the Managers Risk Committee meeting and included in an emerging risk log which is reviewed annually by ARCO. Risk Rating A rating for each risk is determined by assessing its probability and impact of the event if it occurs. The rating assists the Board with the prioritisation and management of risks and demonstrates the importance of the mitigation or controls in place. The assessment of each risk is on the basis of Inherent Risk and Residual Risk after taking into account the strength of current risk management procedures in place. All risks on the Business Risk Log are re-assessed on an ongoing basis and at least annually by the Managers and by ARCO and the Board. Each Risk Owner or function head continuously monitors the risks for which they are responsible. Own Risk and Solvency Assessment ( ORSA ) The ORSA is the process used by the Association to manage its financial and solvency position over the period of its Corporate Plan and the ORSA overview report is the culmination of this process into a report reviewed by the Board. As such, it is an intrinsic part of the Association s Corporate Planning Process. The key elements of the ORSA process are: An analysis of the Association s recent performance Assessment of the Association s risk profile Consideration of business planning and stress scenarios The ORSA overview document is produced twice each year in May and October. ARCO reviews the ORSA and recommend it for approval and use by the Board. The Board reviews and approves the ORSA and considers appropriate action for the Association such as: Capital related decisions 19 Page
General Increase considerations Reassessment of risk profile and risk appetite Additional risk mitigating actions The Association has set its Risk Appetite and documented this within the Risk Appetite Statement. The Board assess the adequacy of Capital against this Risk Appetite statement. To date theses assessments indicate that the Association is adequately capitalised. Risk Controls The Association s Risk Management Framework has been developed to manage risks across the business, using internal control policies, procedures and processes to control risks. Whereas ultimate control for each risk rests with the Board, day-to-day control is exercised by the Risk Owners unless otherwise stated, as set out in the Business Risk Log. The appropriateness and effectiveness of controls is monitored and confirmed by Risk Owners and, for key controls, independently assessed by the Risk Officer. Risk Mitigation Reinsurance One of the key risk mitigation techniques available for the Association is reinsurance. The Association considers its whole account reinsurance options leading up to a new policy year. Proposed reinsurance arrangements are analysed by the Actuarial Function, using the internal model, the Managers Risk Committee and the Reinsurance Group. International Group Pool This can be considered to be a specialised form of reinsurance. The International Group Pool allows for large insurance risks to be shared between its thirteen P&I club members. The International Group also arranges an excess of loss reinsurance programme to cover the risks at higher levels. Other risk mitigation techniques may be utilised from time to time, for example the use of hedging instruments to mitigate the risk of swings in foreign exchange rates. Risk Reporting Procedures Risk Owners are required to provide six-monthly reports on the risks for which they are responsible, based on a template of questions compiled by the Risk Officer. These reports are summarised into key themes and form the basis of an annual Risk Report to the Audit & Risk Committee which is then escalated to the Board. 20 Page
Any amendments to the Business Risk Log proposed by Risk Owners, such as changes to controls or risk descriptions or potential amendments to the ratings are discussed with the Audit & Risk Committee for recommendation for approval by the Board. Risk Owners also identify operational risk loss or near miss events. Integrated and embedded into the organisational structure and decisionmaking processes The Risk Management Function is fulfilled by the Association s Risk Officer and the Managers Risk Committee. The function maintains an organisationwide and aggregated view of the risk profile of the Association, including monitoring risk tolerances against appetite, and advising on how risks might impact the business singly and in combination. This analysis includes stress and scenario testing. The integration of risk management processes with business activities is performed through the requirement for business function heads, who are also risk owners, to focus on risk management on an ongoing basis whilst ensuring that the risks for which they are responsible remain within risk tolerance. This demonstrates the proactive application of risk management techniques to support the business processes and decision-making for which they are also responsible in their day-to-day insurance business activities. B.4. Internal Control System Internal control is defined as a continually operating process effected by the Association s Board, ARCO, the Managers, all staff and systems and designed to support the Association in achieving its business plan objectives through efficient and effective operations and to protect its resources. Each Risk Owner, as named in the Business Risk Log, is responsible for the application of the Internal Control Framework and the design, development, implementation, documentation and maintenance of effective internal control processes in their area and reporting thereon. Control activities Control activities are the actions taken or systems put in place to address business risks, protect assets and ensure that all material control failures and issues are identified and managed. The control activities are embedded into plans, policies, procedures, systems and business processes. Their effectiveness relies on the level of compliance by management and staff. Control environment The Managers are responsible for establishing and maintaining an effective control environment throughout the organisation. In furtherance of that, there is a culture which values the highest levels of integrity in the staff, together with openness and honesty in relation to the conduct and reporting of all activities. Policies, procedures and processes are designed to define and 21 Page
support effective, efficient and appropriate activities at every level of the business. ARCO seeks assurance and provides, through the processes set out in the Compliance policy or through internal audit, assurance to the Board that the scope and quality of compliance monitoring and reporting on regulatory compliance are sufficient to ensure the effectiveness of this Policy and of the management of regulatory compliance risk. All reviews are carried out at least annually and ad hoc as circumstances require. Internal Audit is authorised to investigate and challenge any actions or concerns without influence from the business; be independent of operational business functions and without undue influence from the Board or other functions/management; have unfettered and direct access to all activities in its area of responsibility, including all documentation, systems, staff, Management, executive and non-executive Board members; and have direct access to the Chairman of the Audit, Regulatory & Risk Committee. Compliance function The Board bears ultimately responsibility for Regulatory Compliance, and is supported by the Audit and Risk Committee. The Association takes a risk-based approach to regulatory compliance, focussing on preventing breaches to regulatory principles and other rules and informing the relevant regulators of any that are material, or must be reported to regulators on a mandatory basis. The Compliance Function advises on and promotes compliance with applicable laws, regulatory requirements and administrative provisions and coordinates and monitors implementation of policies, processes and procedures to achieve compliance across the business, and manages regulatory compliance risk. Regulatory developments are monitored for impact on the Association by the Compliance function. Breaches and associated remedial action are posted to the Operational Risk Database. B.5. Internal Audit Function Internal Audit is the third line of defence in the Association s internal control framework, established to provide independent assurance that the systems of internal control established by management ( first line ) and the monitoring and oversight provided by the Risk Management and Compliance Functions ( second line ) are fit for purpose and operating effectively. The objectives of the Internal Audit Function are to provide independent assurance that business risks are identified and are being well managed and controlled by effective systems of internal control. 22 Page
The Internal Audit function of the Association is provided by the Managers who employ an independent Head of Internal Audit (HIA) who in turn reports to the Chair of ARCO. The HIA may engage third parties to conduct some Audits under his/her management if it is felt that specific technical skills are required or where insufficient general audit resource is available. Independence The Internal Audit Function is independent from the organisational activities audited and free to exercise its assignments without impairment and on its own initiative in all areas. It is not authorised to carry out any operational work on behalf of any area of any business. The Head of Internal Audit reports directly to the Chair of the Audit and Risk Committee. B.6. Actuarial Function The Association's Board is ultimately responsible for ensuring an effective Actuarial Function. This function is performed by the TM Actuarial Team, led by its Chief Actuary. The Actuarial Function is independent of the Association s management team and therefore able to undertake its duties in an objective, fair and independent manner. However, for operational purposes, the Actuarial Function is integrated into the Association s internal control system through its role on the Managers committees and attendance at Board meetings. The Actuarial Function makes a significant contribution to the Association s Risk Management Framework by operating its capital model and running the ORSA process and related decisions. B.7. Outsourcing The Association has in place an outsourcing policy which is directed at services or activities which are particularly important or critical to the Association s business (material business activities). A material business activity is one that has the potential, if disrupted, to have a significant impact on the Association s business operations or its ability to manage risks effectively. Management outsourcing The Association has no internal executive function and its management is wholly outsourced to the Managers under management agreements. In order to comply with its regulatory obligations, the Board has developed monitoring and reporting procedures and has delegated to ARCO to monitor internal controls and risk. The risk control and reporting procedures to be followed by the Managers form part of their obligations under the management agreement. The Committee reports to the Board. 23 Page
Investment management outsourcing Management of the Association s investments is outsourced to Thomas Miller Investment Limited, part of Thomas Miller, under investment management agreements. The performance of the investment managers is monitored and supervised by the Board and the Investment Committee. Internal audit outsourcing The Association s internal audit function is outsourced to Thomas Miller Internal Audit. Internal Audit is supervised by the Audit and Risk Committee and the Board. Oversight The Board bears ultimate responsibility for outsourced functions, services, or activities and related governance. The Board are supported by the Audit and Risk Committee which review outsourcing arrangements and the TM P&I(E) Board which monitors the activities of the Association, including outsourcing. B.8. Any Other Information The Association considers no other information material to be disclosed. 24 Page
C. Risk Profile The key areas of risk impacting the Association can be classified as follows: 1. Insurance risk incorporating underwriting and reserving risk 2. Market risk incorporating investment risk, interest rate risk and currency rate risk 3. Credit risk being the risk that a counterparty is unable to pay amounts in full when due 4. Liquidity risk being the risk that cash may not be available to pay obligations as they fall due 5. Operational risk being the risk of failure of internal processes or controls. The Board has established its appetite for risk in relation to its business strategy and available resources. The Board seeks to maximise their resources by effective risk management techniques. Therefore a risk management system has been developed to identify and mitigate risk. As part of the risk management system, the Board has developed an internal model to cover underwriting risk. The model is tailored specifically to the underwriting risk accepted by the Association and therefore provides the Board with the expected outcome of a given scenario. This allows the Board to consider more accurately the effectiveness and efficiency of risk mitigation techniques such as reinsurance. The model is designed to encompass the full spectrum of underwriting risks to which the Association is exposed. C.1. Underwriting Risk The Association is a mono-line insurer, underwriting only protection and indemnity insurance for the shipping community. Underwriting risk is the risk that the Association s net insurance obligations (i.e. claims less premiums) are different to expectations. The Association considers the risk of existing obligations (Reserve Risk) separately to the risk of future obligations (Premium Risk). Reserve risk is managed by the Association s reserving policy. The Association establishes provisions for unpaid claims, both reported and unreported, and related expenses to cover its expected ultimate liability. These provisions are established through the application of actuarial techniques and assumptions. In order to minimise the risk of understating these provisions the assumptions made and actuarial techniques employed are reviewed in detail by management and ARCO. 25 Page
The Board considers that the liability for insurance claims recognised in the consolidated statement of financial position is adequate. However, actual experience will differ from the expected outcome. Premium risk is managed by an underwriting policy which establishes robust underwriting practices in order to meet business needs and satisfy regulatory control. This is supplemented with a robust forecasting approach undertaken as part of the Association s ORSA process. The underwriting process is based on a thorough understanding of the risk accepted. This understanding is enhanced as: The Association is a mono line insurer and has provided broadly the same cover for many years. The Board and Members Committee of the Association include representatives from a full cross section of the shipping community so giving insight into changes in the risk accepted by the Association over time. Underwriting authority is delegated to specific individuals who operate under set underwriting parameters and the ongoing guidance and review of senior management. Underwriting Risk is mitigated via the Association s reinsurance programme. The programme comprises excess of loss reinsurance cover purchased jointly with other members of the International Group, the International Group Pooling agreement and reinsurance to claims within the claims retained by the Association within the Pool deductible. The excess of loss reinsurance cover purchased jointly with other members of the International Group provides cover for claims arising from mutual business which exceed $100 million up to a limit of $3.1 billion. The International Group Pooling agreement provides a sharing of claims costs between thirteen member Clubs. The share attributable to each member is calculated for each policy year on an agreed formula including an adjustment for each Club s historic loss record on the Pool. In addition to the reinsurance purchased externally, the primary insurer, UK(E) reinsures 90% of its residual risks to its parent company, UK(B). In addition, part of the International Group Pool is reinsured to a captive reinsurance vehicle, Hydra. The Association has its own segregated cell within Hydra which transacts only with the Association. Hydra also accepts a proportion of the risk covered by the joint reinsurance contract for claims above $30 million. C.2. Market Risk Market risk arises through fluctuations in market valuations, interest rates, corporate bond spreads and foreign currency exchange rates. Such movements will affect not only the Association s investments, but also the 26 Page